Finance Republicans chart their own course for tax reform... 1 Tax reform proposal clears Ways and Means... 21

Transcription

1 Tax News & Views Capitol Hill briefing. In this issue: Finance Republicans chart their own course for tax reform... 1 Tax reform proposal clears Ways and Means Finance Republicans chart their own course for tax reform Senate Finance Committee Chairman Orrin Hatch, R-Utah, on November 9 released his version of a comprehensive tax reform proposal aimed at reducing rates and providing other tax relief for corporations, individuals, and passthrough entities that would be paid for in large part by eliminating or paring back dozens of current-law deductions, credits, and incentives. The Tax Cuts and Jobs Act, which was released as a technical summary rather than in legislative language. (The Finance Committee typically marks up conceptual language and releases a formal statutory proposal closer to the time a bill is ready to move to the Senate floor.) The measure broadly follows the contours of the tax reform bill bearing the same name that was approved in the House Ways and Means Committee earlier in the day. (See separate coverage in this issue for more on the Ways and Means mark-up. For a detailed summary of the Ways and Means bill as originally released on November 2, see Tax News & Views, Vol. 18, No. 40, Nov. 3, 2017.) URL: s%20mark.pdf URL: But the Finance proposal also lives up to Hatch s oft-repeated promise that Senate Republican taxwriters would not simply rubber stamp any tax reform legislation put forward by their House counterparts. Most notably, the Finance Committee proposal, like the Ways and Means bill, would reduce the corporate tax rate to 20 percent; however the Finance proposal would delay implementation of the rate cut until 2019, while the Ways and Means provision would be effective beginning in The Finance bill provides significant relief from the estate tax but stops short of the full Tax News & Views Page 1 of 23 Copyright 2017 Deloitte Development LLC

2 repeal included in the Ways and Means package. It proposes no changes to the current-law deduction for mortgage interest on home purchases (which the Ways and Means bill would cap at interest paid on loan amounts of up to $500,000); but it would fully repeal the deduction for state and local taxes (something House taxwriters would retain, although only for property taxes and even then subject to a cap). In a revenue estimate released in conjunction with the technical summary, the Joint Committee on Taxation (JCT) staff projects that the Finance Committee bill would increase the deficit by just under $1.5 trillion over the 10-year budget window ( ). The recently approved unified budget resolution for fiscal year 2018 affords fast-track budget reconciliation protections to a tax bill that increases the federal deficit on net by up to $1.5 trillion over 10 years. Of note, the revenue loss in the last year of that window is more than $216 billion, suggesting the measure would not be compliant with the Byrd Rule (which requires reconciliation bills to not increase the deficit outside the current budget window), foreshadowing that major and potentially unpopular surgery will need to be done to the bill before it can be taken up by the full Senate. URL: This discussion looks at the key ways in which the Finance proposal differs from the Ways and Means proposal and considers what s ahead as Hatch makes plans for a Finance Committee mark-up and eventual consideration on the Senate floor. Corporate tax provisions In general, the Finance Committee proposal contains corporate tax provisions similar to those in the Ways and Means bill. There would still be softening of the double taxation of much corporate income due to rate reduction, however, and more fundamental changes in the cross-border context (discussed elsewhere in this report), but without an adoption of a direct corporate integration measure, as may have been expected in the Senate version. Furthermore, similar to the Ways and Means bill, transactions with respect to stock of a corporation will generally be treated the same as under current law, and the proposal does not include changes to the consolidated return provisions. Corporate rate reduction: The Finance Committee proposal would reduce the general corporate tax rate to 20 percent for taxable years beginning after December 31, This would appear to delay implementation of the reduction by one year, as compared to the Ways and Means bill. The Finance Committee proposal would eliminate the current brackets and the special tax rate for personal service corporations. As in the Ways and Means bill, the corporate alternative minimum tax would also be eliminated. Dividends received deduction: The Finance Committee proposal would reduce the dividends received deduction (the DRD, applicable to corporate shareholders receiving a dividend from certain domestic corporations) for the 70 percent and 80 percent brackets, to 50 percent and 65 percent, respectively. The 100 percent DRD would remain intact for dividends from affiliated group members. This appears to be the identical provision in the Ways and Means bill, as amended, and would generally retain the current effective tax rate on such distributions after reducing the corporate tax rate. There are also DRD provisions related to the international tax provisions in the Finance Committee proposal (discussed elsewhere in this report). Modification of the net operating loss deduction: As in the Ways and Means bill, the Finance Committee proposal would modify aspects of current law regarding net operating losses (NOLs). Under current law, NOLs generally have a carryback period of two years and a carryforward period of 20 years. As in the Ways and Means bill, the NOL carryback period would generally be eliminated and the carryforward period would become indefinite. Similarly, the amount of the NOL deduction allowed would be limited to 90 percent of taxable income computed without regard to the NOL deduction. In the Ways and Means bill, the amount of NOLs, or so-called indefinite NOLs, carried to a succeeding year would be increased by an annual interest factor. There is no mention of the increase in the Finance Committee proposal. Conforming amendments would appear to include (1) the repeal of carrybacks of specified liability losses defined in section 172(f) and (2) excess interest losses related to corporate equity reduction transactions under section 172(g) (the so-called CERT rules), but this was not explicit in the Finance Committee proposal (although included in the Ways and Means bill). Tax News & Views (Special Edition) Page 2 of 23 Copyright 2017 Deloitte Development LLC

3 In general, the effective date is December 31, 2017, with the amendments to carryback and carryforward periods applying to NOLs arising in taxable years beginning after December 31, 2017, and with the limitation to NOL utilization (tied to 90 percent of taxable income) applying to taxable years beginning after December 31, Limitation on business interest: Under current law, section 163(j) limits the ability of certain corporations to deduct interest paid or accrued on indebtedness. In general, this limit applies to interest paid or accrued by certain corporations (where no US federal income tax is imposed on the interest income) whose debt-to-equity ratio exceeds 1.5 to 1.0, and where net interest expense exceeds 50 percent of its adjusted taxable income. The Finance Committee proposal would expand interest deductibility consistent with the Ways and Means bill with certain adjustments (as described below). The general rule appears to remain the same: the new provision would generally limit the interest deduction on business interest to (1) business interest income plus (2) 30 percent of the taxpayer s adjusted taxable income. Business interest and business interest income appear to be defined in the same manner as in the Ways and Means bill (i.e., generally, as allocable to a trade or business and not investment interest and income, within the meaning of section 163(d)). Adjusted taxable income is computed without regard to any (1) item of income, gain, deduction, or loss, which is not allocable to the trade or business; (2) business interest income or expense; (3) the 17.4 percent deduction for certain passthrough income (as described elsewhere in this report); and (4) the net operating loss deduction, but taking into account depreciation, amortization, and depletion (which would differ from the Ways and Means bill). The limitation described above generally applies at the taxpayer level. There are special rules that apply to partnerships (see below). In the case of a group of affiliated corporations that file a consolidated return, the Finance Committee proposal appears to clarify that the limitation applies at the consolidated tax return filing level. For partnerships, the limitation is applied at the partnership level, with business interest expense taken in account in determining the partnership s nonseparately stated taxable income or loss. A partner may also be subject to the new interest deduction limitation with respect to the partner s own business interest expense. If so, the adjusted taxable income of the partner will not include such partner s distributive share of the nonseparately stated income or loss of such partnership. This avoids double counting of adjusted taxable income to allow for interest deductibility twice for the same taxable income. The partnership, however, may have excess taxable income. This excess taxable income may be taken into account by the partner in computing the partner s limitation. This allows the partner to deduct more business interest if the partnership could have deducted more business interest. The Finance Committee proposal would generally apply to all taxpayers. Consistent with the Ways and Means bill, an exception applies for certain small businesses (with a slightly different standard) and for interest allocable to performing services as an employee and businesses of certain regulated public utilities. While the Ways and Means bill exempted a real property trade or business (as defined in section 469(c)(7)(C)) in its entirety, the Finance Committee proposal allows, at the taxpayer s election, a taxpayer not to apply the limitation to certain real property-related businesses: real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business. The Ways and Means bill but not the Finance Committee proposal included, via amendment, a narrow exception for so-called floor plan financing indebtedness that, in general, would apply to certain financing of motor vehicle acquisitions. Business interest that is not otherwise allowed as a deduction by reason of 163(j) would be treated as paid or accrued in the succeeding taxable year, and could be carried forward indefinitely. The Ways and Means bill would permit carryforwards only to the fifth taxable year following the year of the payment or accrual of interest. Similar to the Ways and Means bill, it appears that section 381(c) would be amended under the Finance proposal to include disallowed business interest as a tax attribute thereunder, and section 382 would be amended to treat disallowed business interest as a pre-change loss under subsection (d). The Finance Committee proposal, like the Ways and Means bill, contains a separate interest deduction limitation provision that applies to domestic corporations that are members of worldwide affiliated groups (discussed elsewhere in this report). The separate interest deduction limitations can both apply, and the amount of interest expense carried forward would reflect the lesser of the amount deductible under the provisions. The modifications described above apply to taxable years beginning after December 31, Tax News & Views (Special Edition) Page 3 of 23 Copyright 2017 Deloitte Development LLC

4 Contributions to capital: The Finance Committee proposal would not revoke current section 118, which generally provides that a corporation will not recognize gross income upon a contribution to its capital. The Ways and Means bill included a provision to revoke section 118 and to provide for certain other amendments (including the revocation of section 108(e)(6)). The language of the Ways and Means bill could be read to extend to shareholder contributions to capital, which would represent a stark and perhaps unintended departure from current law. Alternative Minimum Tax Like the Ways and Means bill, the Finance Committee proposal would repeal the alternative minimum tax (AMT) for individuals, estates, trusts, and corporations for tax years beginning after December 31, Also like the Ways and Means bill, taxpayers may claim a refund on any AMT credit carryovers. Under the Finance Committee proposal, taxpayers may claim 50 percent of remaining AMT credits in tax years 2018, 2019, and Taxpayers would be able to claim a refund on all remaining credits in the tax year This is in contrast to the Ways and Means bill, where the full amount of the AMT credit might not be taken until Cost recovery The Finance Committee proposal modifies section 168 bonus depreciation to allow for full expensing of qualified property placed into service after September 27, 2017, but before January 1, 2023 (with an additional year for longer production period property and certain aircrafts). The Finance Committee proposal s temporary full expensing provision is substantially similar to that of the Ways and Means bill. The Finance Committee proposal also excludes various public utility properties from the full expensing provision. It does not specify whether the full expensing provision applies only to original use property, or if this rule is eliminated (like it was in the Ways and Means bill). Revenue recognition The Finance proposal requires taxpayers to recognize income no later than the taxable year in which such income is taken into account as income on the taxpayer s applicable financial statement. However, long-term contract income to which section 460 applies is exempt from this rule. For example, any unbilled receivables for partially performed services must be recognized to the extent the amounts are taken into income for financial statement purposes. The bill also codifies the deferral method of accounting for advanced payments for goods and services currently provided under Rev. Proc Thus the proposal is intended to override the exception in Treasury Reg. Section (c). Furthermore, the bill directs taxpayers to apply the revenue recognition rules under section 451 before applying the OID rules under section These provisions would be effective for the taxable year beginning after December 31, There was no such provision included in the Ways and Means bill. Special rules for taxable year of inclusion The Finance proposal contains an accounting method provision that would affect the timing of income recognition generally, including the timing of income with respect to a debt instrument. With regard to debt, the proposal would require inclusion of certain items based on the treatment of an item on the financial statements of the taxpayer. Otherwise, the effect of the provision on the tax accounting for debt is unclear. Like-kind exchanges of real property Like the Ways and Means bill, the Finance Committee proposal limits the scope of like-kind exchange nonrecognition treatment to real property not held primarily for sale. The Finance Committee proposal also provides for transition rules similar to that of the Ways and Means bill. Deduction for local lobbying expenses Unlike the Ways and Means bill, the Finance Committee proposal would not repeal the deduction for local lobbying expenses. Tax News & Views (Special Edition) Page 4 of 23 Copyright 2017 Deloitte Development LLC

5 Section 199 Deduction Like the Ways and Means bill, the Finance Committee proposal repeals the section 199 deduction. However, the effective date of the repeal in the Finance Committee proposal is for taxable years beginning after December 31, 2018, one year later than the Ways and Means bill. Limitation on deduction by employers for fringe benefit expenses Under the Finance Committee proposal, no deduction is allowed with respect to (1) an activity generally considered to be entertainment, amusement or recreation, (2) membership dues with respect to any club organized for business, pleasure, recreation or other social purposes, or (3) a facility (such as an airplane) used in connection with any of the above items. Thus, the proposal repeals the current exception to the deduction disallowance for entertainment, amusement, or recreation that is directly related to (or, in certain cases, associated with) the active conduct of the taxpayer s trade or business, as well as the related rule applying a 50 percent limit to such deductions. While the proposal retains the 50 percent deduction for food and beverage expenses associated with the operation of a taxpayer s trade or business (for example, meals consumed by employees on work travel), the proposal expands the 50 percent limitation to employer expenses associated with providing food and beverages to employees through an eating facility that meets the requirements to be considered a de minimis fringe benefit under current law. The proposal also disallows the deduction for expenses associated with providing any qualified transportation fringe benefit to employees. In addition, the deduction for expenses incurred for providing transportation (or any payment or reimbursement) related to commuting between the employee s residence and place of employment, other than as necessary for ensuring the safety of an employee, is disallowed under the proposal. These provisions would be effective taxable years beginning after These provisions are broadly similar to the proposals in the House bill although the extension of the 50 percent limitation on food and beverage expenses provided through an eating facility is new. Treatment of self-created property Unlike the Ways and Means bill, the Finance proposal does not exclude patents, inventions, models or designs, or secret formulas or processes as capital assets. Thus, as under current law, these assets would be treated as capital assets. Sale or exchange of patents Unlike the Ways and Means bill, the Finance Committee proposal does not include a provision to repeal section 1235, which treats any gain from the transfer of a patent from its creator to an unrelated individual as long-term capital gain. Depreciation on luxury automobiles and personal use property The Finance Committee proposal increases the depreciation limitation under section 280F, for property placed in service after December 31, The maximum amount allowable for listed property under section 280F, for which additional first-year depreciation deduction under section 168(k) is not claimed, is increased to $10,000 in the first year, $16,000 in the second year, $9,600 in the third year, and $5,760 for the fourth and later years. The Finance Committee proposal also removes computer or peripheral equipment from the definition of listed property under section 280F. The Ways and Means bill did not modify the provisions of section 280F. Depreciation of farm property The Finance Committee proposal shortens the recovery period from seven to five years for any machinery or equipment used in a farming business. The original use of such equipment must commence with the taxpayer and placed in service after December 31, The bill also repeals the required use of the 150 percent declining balance method for property used in a farming business, except for 15-year or 20-year property used in the farming business to which the straight line method does not apply, or for property which the taxpayer elects to use the 150-percent declining balance method. The Ways and Means bill did not modify the farming property recovery provisions. Tax News & Views (Special Edition) Page 5 of 23 Copyright 2017 Deloitte Development LLC

6 Recovery period of real property The Finance Committee proposal shortens the recovery period for nonresidential real and residential rental property to 25 years. The bill also eliminates the separate definitions of qualified leasehold improvements, qualified restaurants, and qualified retail improvement property, but rather provides for a general 10-year recovery period for qualified improvement property, and a 20-year ADS recovery period for such property. The bill also requires a real property trade or business that elects out of the limitation on the deduction for interest to use ADS to depreciate any of its nonresidential real property, residential rental property, and qualified improvement property. These provisions apply to property placed in service after December 31, A similar provision was not included in the Ways and Means bill. Business credits Orphan drug credit: The Finance proposal modifies the orphan drug credit, a tax credit for clinical testing expenses for certain drugs for rare diseases or conditions. Internal Revenue Code (IRC) section 45C currently provides a 50 percent credit for qualified clinical testing expenses incurred in the testing of certain drugs to treat rare diseases or conditions. The Finance proposal limits the orphan drug credit to 50 percent of so much of qualified clinical testing expenses for the taxable year as exceeds 50 percent of the average qualified clinical testing expenses for the three taxable years preceding the taxable year for which the credit is being determined. In the case where there are no qualified clinical expenses during at least one of the three preceding taxable years, the credit is equal to 25 percent of qualified expenses. Aggregation and other special rules similar to those applicable to the research credit apply where there are controlled groups of corporations, estates and trusts claiming the credit, mergers and acquisitions of taxpayers, and short taxable years. Under the proposal, taxpayers may elect a reduced credit in lieu of reducing otherwise allowable deductions in a manner similar to the research credit under section 280C. In addition, the proposal limits qualified clinical testing expenses to the extent the testing giving rise to such expenses is related to the use of a drug which has previously been approved under section 505 of the Federal Food, Drug, and Cosmetic Act for use in the treatment of any other disease or condition, if all such diseases or conditions in the aggregate (including the rare disease or condition with respect to which the credit is otherwise being determined) affect more than 200,000 persons in the United States. The Finance Committee proposal applies to amounts paid or incurred in taxable years beginning after December 31, This provision is estimated to raise $29.7 billion over 10 years. Rehabilitation credit: The Finance Committee proposal modifies the rehabilitation credit under IRC section 47 for the restoration of old and historic buildings. Currently, a 20 percent credit is provided for qualified rehabilitation expenditures with respect to a certified historic structure, and a 10 percent credit is provided for qualified rehabilitation expenditures with respect to a qualified rehabilitated pre-1936 building. The Finance proposal repeals the 10 percent credit for pre-1936 buildings. Under the proposal, a 10 percent credit (not 20 percent) is provided for qualified rehabilitation expenditures with respect to a certified historic structure. The Finance proposal applies to amounts paid or incurred after December 31, A transition rule provides that in the case of qualified rehabilitation expenditures (for either a certified historic structure or a pre-1936 building), with respect to any building owned or leased by the taxpayer at all times on and after January 1, 2018, the 24-month period selected by the taxpayer (under section 47(c)(1)(C)) is to begin not later than the end of the 180-day period beginning on the date of the enactment of the Act, and the amendments made by the proposal apply to such expenditures paid or incurred after the end of the taxable year in which such 24-month period ends. This provision is estimated to raise $4.3 billion over 10 years. Deduction for unused business credits: The Finance proposal would repeal the deduction for certain unused business credits under IRC section 196. Currently, section 196 allows a deduction to the extent that certain portions of the general business credit expire unused after the end of the carryforward period. The Finance Committee proposal repeals the deduction for certain unused business credits, effective for taxable years beginning after December 31, This provision is estimated to have a negligible revenue effect. Tax News & Views (Special Edition) Page 6 of 23 Copyright 2017 Deloitte Development LLC

7 Other general business credits: Notably, the Finance proposal does not modify current law as it relates to other general business credits, including the new markets tax credit, work opportunity tax credit, production tax credit and energy credit. The Finance proposal also retains the current-law research and development tax credit and the lowincome housing credit. The House proposal included a provision that would repeal the 4 percent low-income housing credit coupled with tax-exempt bond financing. Small business provisions Section 179 expensing: The Finance Committee proposal increases the section 179 expense election threshold to $1 million, which is significantly lower than the $5 million limit provided under the Ways and Means bill. The phase-out of this expense election begins at $2.5 million, which is also significantly lower than the $20 million provided in the Ways and Means bill. The Finance Committee proposal expands the definition of section 179 property to include certain property used in furnishing lodging, and roofs, heating, ventilation, air-conditioning property, fire protection and alarm systems, and security systems for nonresidential real property that are placed in service after December 31, In contrast, the Ways and Means bill only expanded section 179 property to include certain energy efficient heating and air-conditioning property. Accounting methods: The Finance Committee proposal expands the scope of eligible taxpayers who may use the cash method of accounting. The Finance Committee proposal allows taxpayers with annual average gross receipts of $15 million or less to use the cash method. This gross receipt limit would also would apply to farming C corporations. In contrast, the Ways and Means bill increased the average gross receipts threshold to $25 million. The Finance Committee proposal also generally exempts taxpayers that meet the $15 million gross receipts test from the requirement to keep inventories. Rather, these taxpayers can treat inventories as either nonincidental materials and supplies or conforming to its financial accounting treatment. Taxpayers qualifying under the $15 million gross receipts test are also excluded from the uniform capitalization rules under section 263A. These exemptions are similar to that of the Ways and Means bill, except the Ways and Means bill s gross receipts threshold is $25 million. The bill also expands the exception for small construction contracts from using the percentage-of-completion method under section 460 for contracts that are expected to be completed within two years of commencement of the contract, and that are performed by a taxpayer that meets the $15 million gross receipts test. In contrast, the Ways and Means bill exempts taxpayers from the percentage-of-completion method under a $25 million gross receipts threshold. Transition to territoriality Dividends received deduction: The proposal provides for a 100 percent dividends received deduction for the foreign-source portion of dividends received from specified 10-percent-owned foreign corporations by domestic corporations that are United States shareholders. For this purpose, an amount received by a domestic corporation that is treated as a dividend under section 1248, is treated as a dividend for purposes of the DRD (provided the holding period requirements are satisfied). In addition, if the gain is recognized by a lower tier controlled foreign corporation (CFC) and characterized as a dividend under section 964(e), then such amount is included in subpart F income for the year of the sale but the US shareholder can claim a DRD with respect to such amount. No foreign tax credit or deduction is allowed for taxes paid or accrued with respect to such dividend that qualifies for the DRD. Similar to the Ways and Means Committee bill, a specified foreign corporation is any foreign corporation with a domestic corporation as a United States shareholder. However, key differences with the Ways and Means Committee bill include: (1) a limitation on the DRD for any dividend received if the foreign corporation receives a deduction (or other tax benefit) from taxes imposed by a foreign country (hybrid dividend) and (2) an expanded holding period requirement (double that included in the Ways and Means Committee bill). In addition, the explanation provides that any hybrid dividend received by a controlled foreign corporation is treated as subpart F income for the taxable year such dividend was received. Limitation on losses with respect to 10-percent-owned foreign corporations: Similar to the Ways and Means Committee bill, the basis in foreign corporations with respect to which the dividends received deduction applies is Tax News & Views (Special Edition) Page 7 of 23 Copyright 2017 Deloitte Development LLC

8 reduced by the amount of any such dividend, but only for purposes of computing loss on the sale or exchange of that stock. Taxation of deferred foreign income upon transition: Similar to the Ways and Means Committee bill, a US shareholder of a foreign corporation must include in income for the subsidiary s last tax year beginning before January 1, 2018, the shareholder s pro rata share undistributed, nonpreviously taxed post-1986 foreign earnings. Earnings and profits (E&P) is only taken into account to the extent it was accumulated during periods when the foreign corporation had at least one US shareholder. The amount of such E&P is determined as of November 9, 2017, or other applicable measurement date as appropriate (and as of yet unspecified), unreduced by distributions during the taxable year to which the provision applies. The mandatory inclusion generally may be reduced by foreign earnings and profits deficits that are properly allocable to that person. For purposes of this provision, the E&P is classified as either E&P that has been retained in the form of cash or cash equivalents, or E&P that has been reinvested in the foreign subsidiary s business (for example, property, plant, and equipment). The portion of the E&P comprising cash or cash equivalents is taxed at a reduced rate of 10 percent, while any remaining E&P is taxed at a reduced rate of 5 percent. Rules will be provided to avoid the double counting of cash assets. Limitation on assessment extended: The Finance Committee proposal extends the assessment statute of limitations for taxpayers reporting a mandatory inclusion. The assessment statute of limitations is extended to six years from the date upon which the return was filed that initially reflects the mandatory inclusion. Consistent with the Ways and Means Committee bill: Like the Ways and Means bill, the Finance Committee proposal provides that: (1) foreign tax credit carryforwards are fully available, and foreign tax credits triggered by the deemed repatriation are partially available, to offset the US tax; (2) at the election of the US shareholder, the tax liability would be payable over a period of up to eight years; and (3) special rules would apply with respect to S corporations and their shareholders. Rules related to passive and mobile income Global intangible low-taxed income: The Finance Committee bill includes a provision designed to tax currently global intangible low-taxed income (GILTI). For purposes of this bill, GILTI is the excess of the shareholder s net tested income over the deemed tangible income return, which is defined as 10 percent of the shareholder s basis in tangible property used to produce tested income. Similar to the House FHRA provision, tested income for this purpose is the gross income of the corporation determined without regard to the following exceptions: (1) the corporation s effectively connected income under section 952(b); (2) any gross income taken into account in determining the corporation s subpart F income; (3) any gross income excluded from foreign base company income or insurance income by reason of the high-tax exception under section 954(b)(4); (4) any dividend received from a related person (as defined in section 954(d)(3)); and (5) any foreign oil and gas extraction income and foreign oil related income, over deductions (including taxes) properly allocable to such gross income under rules similar to the rules of section 954(b)(5). The proposal requires that the amount of GILTI included by a US shareholder be allocated across all of such shareholder s CFCs, based on the CFC s proportionate share of tested income. In addition, the shareholder can claim a foreign tax credit for 80 percent of the taxes paid or accrued with respect to the tested income of each CFC from which the shareholder has an inclusion. Deduction for foreign derived intangible income: In addition to the immediate inclusion of GILTI, the proposal allows a domestic corporation a deduction for 37.5 percent of the lesser of the shareholder s GILTI plus foreign derived intangible income or its taxable income. Foreign derived intangible income is an amount equal to the corporation s deemed intangible income multiplied by an amount equal to the corporation s foreign deduction eligible income over its total deduction eligible income. Tax News & Views (Special Edition) Page 8 of 23 Copyright 2017 Deloitte Development LLC

9 Deduction-eligible income is the gross income of the corporation determined without regard to: (1) the subpart F income of the corporation under section 951; (2) the GILTI of the corporation; (3) any dividend received from a CFC with respect to which the corporation is a US shareholder; and (4) any domestic oil and gas income of the corporation; and (5) any foreign branch income (as defined in section 904(d)(2)(J)) of the corporation, over the deductions (including taxes) properly allocable to such gross income. Deemed intangible income is the excess of a corporation s deduction eligible income over 10 percent of the basis in its tangible depreciable property used to produce deduction eligible income. Foreign-derived deduction eligible income means with respect to a taxpayer for its taxable year, any deduction-eligible income of the taxpayer that is derived in connection with (1) property that is sold by the taxpayer to any person who is not a United States person and that the taxpayer establishes to the satisfaction of the Secretary is for a foreign use or (2) services provided by the taxpayer that the taxpayer establishes to the satisfaction of the Secretary are provided to any person, or with respect to property, not located within the United States. Finally, the bill provides a rule presumably intended to incentivize the onshoring of IP, by providing that if a CFC holds intangible property on the date of enactment, the fair market value of the property on the date of any distribution is treated as not exceeding its adjusted basis. Treatment of hybrid transactions The Finance proposal includes a provision not in the Ways and Means Committee bill that would deny the deduction for any disqualified related-party amount paid pursuant to a hybrid transaction or by or to a hybrid payment. A disqualified related-party amount is any interest or royalty paid or accrued to a related party to the extent that: (1) there is no corresponding inclusion to the related party under the tax law of the country of which such related party is a resident for tax purposes, or (2) such related party is allowed a deduction with respect to such amount under the tax law of such country. A hybrid transaction is any transaction, series of transactions, agreement, or instrument one or more payments with respect to which are treated as interest or royalties for federal income tax purposes and which are not so treated for purposes of the tax law of the foreign country of which the recipient of such payment is resident for tax purposes or is subject to tax. A hybrid entity is any entity which is either: (1) treated as fiscally transparent for federal income tax purposes but not so treated for purposes of the tax law of the foreign country of which the entity is resident for tax purposes or is subject to tax, or (2) treated as fiscally transparent for purposes of the tax law of the foreign country of which the entity is resident for tax purposes or is subject to tax but not so treated for federal income tax purposes. Base erosion proposals Under the Finance bill, a corporation with excess base erosion payments for the taxable year must pay a tax equal to the excess of 10 percent of its taxable income (determined without regard to deductions attributable to base erosion payments) over its regular tax liability reduced by the general business credit and the research credit. For purposes of this provision, a base erosion payment generally means any amount paid or accrued by a taxpayer to a foreign person that is a related party of the taxpayer and with respect to which a deduction is allowable, including any amount paid or accrued by the taxpayer to the related party in connection with the acquisition by the taxpayer from the related party of property of a character subject to the allowance of depreciation (or amortization in lieu of depreciation). A base erosion payment also includes any amount that constitutes reductions in gross receipts of the taxpayer that is paid to or accrued by the taxpayer with respect to: (1) a surrogate foreign corporation which is a related party of the taxpayer, and (2) a foreign person that is a member of the same expanded affiliated group as the surrogate foreign corporation. A surrogate foreign corporation has the meaning given in section 7874(a)(2). Information reporting requirement: The Finance Committee proposal provides for increased information reporting under sections 6038A and 6038C to require certain taxpayers subject to the new base erosion provisions to report information such as base erosion payments, information for determining the base erosion minimum tax, and other information deemed necessary by the Secretary of the Treasury. In addition, it proposes to increase the penalty from Tax News & Views (Special Edition) Page 9 of 23 Copyright 2017 Deloitte Development LLC

10 $10,000 to $25,000 for failure to comply with Section 6038A and increases the penalty for failure to comply within 90 days after IRS notification to $25,000 for each 30 day period thereafter. Additional provisions not included in Ways and Means Committee bill Codification of Rev Rul : Under the Finance Committee proposal, gain or loss from the sale or exchange of a partnership interest is effectively connected with a US trade or business to the extent that the transferor would have had effectively connected gain or loss had the partnership sold all of its assets at fair market value as of the date of the sale or exchange. The proposal requires that any gain or loss from the hypothetical asset sale by the partnership be allocated. In addition, the transferee of a partnership interest is required to withhold 10 percent of the amount realized on the sale or exchange of a partnership interest unless the transferor certifies that the transferor is not a nonresident alien individual or foreign corporation. The provision would apply to partnership taxable years beginning after December 31, Other international provisions unique to the Finance Committee bill would: Modify the definition of a US shareholder to include any US person who owns 10 percent or more of the total value of the foreign corporation (as opposed to vote); Modify the definition of section 936(h)(3)(B) to include workforce in place, goodwill, and going concern value; Terminate DISC; Impose a limitation on claiming lower rates on dividends from certain corporations subject to 7874; Impose a separate foreign tax credit limitation category for branch income; Accelerate the election to allocate interest on a worldwide basis; Repeal the fair market value method for allocating interest expense; and Create a category of income defined as passenger cruise gross income, provide specific rules for determining the extent to which such income is effectively connected with the conduct of a trade or business in the United States, and remove such income from eligibility for the reciprocal exemptions of sections 873 and 883. As a result, effectively connected passenger cruise income is subject to net basis taxation. Other international tax modifications also included in the Ways and Means bill The Finance proposal incorporates other provisions from the Ways and Means bill that would: Eliminate foreign base company oil related as a category of subpart F income; Provide for an inflation adjustment to the de minimis rule; Repeal subpart F inclusions based on the withdrawal of previously excluded subpart F income invested in foreign base company shipping operations; Eliminate the limitation on attribution of stock from a foreign person to a US shareholder; Eliminate the requirement that a foreign corporation must be a CFC for an uninterrupted period of 30 days for subpart F to apply; Permanently extend the section 954(c)(6) lookthrough rule; Repeal section 956 as applied to domestic corporations that own stock directly or indirectly through domestic partnerships; Repeal the section 902 credit and application of the section 960 credit on a current-year basis; and Change the source rules for the sale of inventory property. Modification of insurance exception to the passive foreign investment company rules: The proposal also would modify the requirements for a corporation the income of which is not included in passive income for purposes of the PFIC rules. The proposal replaces the test based on whether a corporation is predominantly engaged in an insurance business with a test based on the corporation s insurance liabilities. Passthrough provisions 17.4 percent deduction of domestic qualified business income: Under the Finance Committee proposal, an individual taxpayer generally may deduct 17.4 percent of domestic qualified business income from a partnership, S corporation, or sole proprietorship. Tax News & Views (Special Edition) Page 10 of 23 Copyright 2017 Deloitte Development LLC

11 Unless a taxpayer s income is below a threshold ($75,000 for single filers, $150,000 for joint filers), the deduction does not apply to specified service businesses (any trade or business activity involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees). This term is similar to the Ways and Means Committee bill s definition of specified service activity and reference to section 1202(e)(3)(A). In the case of a taxpayer who has qualified business income from a partnership or S corporation, the amount of the deduction is limited to 50 percent of the W-2 wages of the taxpayer. W-2 wages of a person is the sum of wages subject to wage withholding, elective deferrals, and deferred compensation paid by the person during the calendar year ending during the taxable year. Only those wages that are properly allocable to qualified business income are taken into account. Qualified business income for a taxable year means the net amount of domestic qualified items of income, gain, deduction, and loss with respect to the taxpayer s qualified businesses (that is, any trade or business other than specified service trades or businesses, defined above). Dividends from a REIT (other than any portion that is a capital gain dividend) are treated as qualified items of income, but certain investment-related income, gain, deductions, or loss are not treated as qualified business income. Qualified business income does not include any amount paid by an S corporation that is treated as reasonable compensation of the taxpayer. Similarly, qualified business income does not include any amount allocated or distributed by a partnership to a partner who is acting other than in his or her capacity as a partner for services, and does not include any amount that is a guaranteed payment for services actually rendered to or on behalf of a partnership to the extent that the payment is in the nature of remuneration for those services. The provision would apply to taxable years beginning after December 31, Tax gain on the sale of a partnership interest on lookthrough basis: Under Rev. Rul , C.B. 107, in determining the source of gain or loss from the sale or exchange of an interest in a foreign partnership, the IRS applied the asset-use test and business activities test at the partnership level to determine the extent to which income derived from the sale or exchange is effectively connected with that US business. Under the ruling, if there is unrealized gain or loss in partnership assets that would be treated as effectively connected with the conduct of a US trade or business if those assets were sold by the partnership, some or all of the foreign person s gain or loss from the sale or exchange of a partnership interest may be treated as effectively connected with the conduct of a US trade or business. However, a 2017 Tax Court case rejects the logic of the ruling and instead holds that, generally, gain or loss on sale or exchange by a foreign person of an interest in a partnership that is engaged in a US trade or business is foreign-source (Grecian Magnesite Mining v. Commissioner, 149 T.C. No. 3 (July 13, 2017). Under the proposal, gain or loss from the sale or exchange of a partnership interest is effectively connected with a US trade or business to the extent that the transferor would have had effectively connected gain or loss had the partnership sold all of its assets at fair market value as of the date of the sale or exchange. The proposal requires that any gain or loss from the hypothetical asset sale by the partnership be allocated to interests in the partnership in the same manner as nonseparately stated income and loss. The proposal also requires the transferee of a partnership interest to withhold 10 percent of the amount realized on the sale or exchange of a partnership interest unless the transferor certifies that the transferor is not a nonresident alien individual or foreign corporation. If the transferee fails to withhold the correct amount, the partnership is required to deduct and withhold from distributions to the transferee partner an amount equal to the amount the transferee failed to withhold. The proposal would provide Treasury and the IRS with specific regulatory authority to address coordination with the nonrecognition provisions of the Code. The proposal is effective for sales and exchanges of partnership interests after December 31, Modification of the definition of substantial built-in loss in the case of transfer of partnership interest: Under current law, a partnership does not adjust the basis of partnership property following the transfer of a Tax News & Views (Special Edition) Page 11 of 23 Copyright 2017 Deloitte Development LLC

12 partnership interest unless either the partnership has made a one-time election under section 754 to make basis adjustments, or the partnership has a substantial built-in loss immediately after the transfer. Under section 743(d), a substantial built-in loss exists if the partnership s adjusted basis in its property exceeds by more than $250,000 the fair market value of the partnership property. The proposal modifies the definition of a substantial built-in loss for purposes of section 743(d), affecting transfers of partnership interests. Under the proposal, in addition to the present-law definition, a substantial built-in loss also exists if the transferee would be allocated a net loss in excess of $250,000 upon a hypothetical disposition by the partnership of all partnership s assets in a fully taxable transaction for cash equal to the assets fair market value, immediately after the transfer of the partnership interest. Therefore, the test for a substantial built-in loss under the proposal applies both at the partnership level and at the transferee partner level. The proposal applies to transfers of partnership interests after December 31, Charitable contributions and foreign taxes taken into account in determining limitation on allowance of partner s share of loss: Under current law, a partner s basis in its partnership interest is increased by its distributive share of income (including tax-exempt income) and is decreased (but not below zero) by distributions by the partnership and its distributive share of partnership losses and expenditures of the partnership not deductible in computing partnership taxable income and not properly chargeable to capital account. In the case of a charitable contribution, a partner s basis is reduced by the partner s distributive share of the adjusted basis of the contributed property. A partnership computes its taxable income in the same manner as an individual with certain exceptions. The exceptions provide, in part, that the deductions for foreign taxes and charitable contributions are not allowed to the partnership. Instead, a partner takes into account its distributive share of the foreign taxes paid by the partnership and the charitable contributions made by the partnership for the taxable year. The Finance Committee proposal modifies the basis limitation on partner losses to provide that a partner s distributive share of items that are not deductible in computing the partnership s taxable income, and not properly chargeable to capital account, are allowed only to the extent of the partner s adjusted basis in its partnership interest at the end of the partnership taxable year in which the expenditure occurs. Thus, the basis limitation on partner losses applies to a partner s distributive share of charitable contributions and foreign taxes. The proposal applies to partnership taxable years beginning after December 31, Loss limitation rules applicable to individuals: Under current law, a limitation on excess farm losses applies to taxpayers other than C corporations. If a taxpayer other than a C corporation receives an applicable subsidy for the taxable year, the amount of the excess farm loss is not allowed for the taxable year, and is carried forward and treated as a deduction attributable to farming businesses in the next taxable year. The Finance Committee proposal expands the limitation on excess farm losses to apply to excess business losses of a taxpayer. Under the proposal, excess business losses of a taxpayer other than a C corporation are not allowed for the taxable year. Such losses are carried forward and treated as part of the taxpayer s net operating loss carryforward in subsequent taxable years. NOL carryovers are allowed for a taxable year up to the lesser of the carryover amount or 90 percent of taxable income determined without regard to the deduction for NOLs. An excess business loss for the taxable year is the excess of aggregate deductions of the taxpayer attributable to trades or businesses of the taxpayer, over the sum of aggregate gross income or gain of the taxpayer plus a threshold amount. The threshold amount for a taxable year is $500,000 for married individuals filing jointly, and $250,000 for other individuals. The $500,000 and $250,000 thresholds are indexed for inflation. In the case of a partnership or S corporation, the proposal applies at the partner or shareholder level. Each partner s or S corporation shareholder s share of items of income, gain, deduction, or loss of the partnership or S corporation are taken into account in applying the limitation under the proposal for the taxable year of the partner or S corporation. The proposal is effective for taxable years beginning after December 31, Tax News & Views (Special Edition) Page 12 of 23 Copyright 2017 Deloitte Development LLC